A credit score in the United States is a number representing the creditworthiness of a person, the likelihood that person will pay his or her debts.

Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers. Widespread use of credit scores has made credit more widely available and cheaper for consumers.[1][2]

Credit scoring models[edit]

FICO score[edit]

The best-known and most widely used credit score model in the United States. The FICO score was created in 1989 and is calculated statistically, with information from a consumer's credit files. The score is sold by the FICO Company.[3] (the name is an acronym derived from the company's original name Fair, Isaac and Company).

It provides a snapshot of risk that banks and other institutions use to help make lending decisions. Applicants with higher FICO scores might be offered better interest rates on mortgages or automobile loans as well as higher credit limit amounts.

Although Experian, a credit reporting agency, categorically states that employers do not receive credit scores,[4] the fact that some employers have used information gleaned from credit reports (in special truncated form or otherwise) in HR decisions has drawn criticism and various states have enacted legislation curtailing or outlawing aspects of this practice.[5]

Also noteworthy is Greg Fisher's website "exploding the myths" in the subject of employer use of credit information.[6][7]

The use of credit information in connection to applying for various types of insurance or in landlord background checks have drawn similar amounts of scrutiny and criticism. This is because the activities of finding secure employment, renting suitable accommodation and securing insurance are the basic functions of meaningful participation in modern society, and in the case of some types of auto insurance for instance, are mandated by law.[8]

Make up of the FICO score[edit]

The approximate makeup of the FICO score used by US lenders

Credit scores are designed to measure the risk of default by taking into account various factors in a person's financial history. Although the exact formulas for calculating credit scores are secret, FICO has disclosed the following components:[9][10]

35%: Payment history—Late payments on bills, such as a mortgage, credit card or automobile loan, will cause a FICO score to drop.[11] Bills paid on time will improve a FICO score.[12]

30%: Credit utilization—The ratio of current revolving debt (such as credit card balances) to the total available revolving credit or credit limit. FICO scores can be improved by paying off debt and lowering the credit utilization ratio.[13] Alternatively, applications for and receiving the credit limit increase will also drive down the utilization ratio. Alternatively, opening new lines of credit will have the same effect (keep in mind the "Average age of tradelines" and "Hard inquiries" matrices on the last possibility). The closing of existing revolving accounts will typically adversely affect this ratio and therefore have a negative impact on a FICO score; if it is an old account being closed, the resultant decrease in average age of open accounts will also cause a decrease in score.

15%: Length of credit history—As a credit history ages it can have a positive impact on its FICO score.[14]

10%: Recent searches for credit—hard credit inquiries, which occur when consumers apply for a credit card or loan (revolving or otherwise), can hurt scores, especially if done in great numbers; often three to five points per inquiry. Individuals "rate shopping" for a mortgage or auto loan over a short period (a fortnight or 45 days, depending on whether old FICO or FICO 08 are used) will likely not experience a large decrease in their scores as a result of these types of inquiries, as automated computer algorithms attempt to detect when a consumer is rate shopping (and not attempting to receive many new lines of credit), and roll all of the hard inquiries into one; this can often take several months, and isn't always effective, although a consumer who believe they have received many hard inquiries on their report while searching for one loan (where the automated system has failed to detect it as such) can dispute these with the credit bureau in question.[16] While all credit inquiries are recorded and displayed on personal credit reports for two years (their effect decreases at the six-month and one-year mark; they have no real effect after the first year), credit inquiries that were made by the consumer (such as pulling a credit report for personal use), by an employer (for employee verification) or by companies initiating pre-screened offers of credit or insurance do not have any impact on a credit score: these are called "soft inquiries" or "soft pulls", and do not appear on a credit report used by lenders, only on personal reports.

Getting a higher credit limit can help your credit score. The higher the credit limit on the credit card, the lower the utilization ratio average for all of your credit card accounts. The utilization ratio is the amount owed divided by the amount extended by the creditor and the lower it is the better your FICO rating, in general. So if you have one credit card with a used balance of $500 and a limit of $1,000 as well as another with a used balance of $700 and $2,000 limit; the average ratio is 40 percent ($1,200 total used divided by $3,000 total limits). If the first credit card company raises the limit to $2,000; the ratio lowers to 30 percent; which could boost the FICO rating.

There are other special factors which can weigh on the FICO score.

Any money owed because of a court judgment, tax lien, etc. carry an additional negative penalty, especially when recent.

FICO score ranges[edit]

There are several types of FICO score: generic, bankcard, personal finance, mortgage, installment loan, auto, NextGen and expansion score. The generic FICO score is between 300 and 850 exhibiting a negative skewed distribution with 60% of people falling between approximately 650 and 799.[18] According to FICO the median score in 2006 was 723, and 711 in 2011.[19] The FICO bankcard score and FICO auto score are between 250 and 900. The FICO mortgage score is between 300 and 850.

Each individual actually has several credit scores for the FICO scoring model because each of three national credit bureaus, Equifax, Experian and TransUnion, has its own database. Data about an individual consumer can vary from bureau to bureau. FICO scores have different names at each of the different credit reporting agencies: Equifax (BEACON), TransUnion (FICO Risk Score) and Experian (Experian/FICO Risk Model). FICO scores are used by 90% of the lenders. People can obtain generic FICO score for Equifax, TransUnion and Experian. Other types of FICO scores cannot be obtained by consumers. Other non-FICO scores are of little use by lenders.

FICO NextGen score[edit]

The NextGen Score is a scoring model designed by the FICO company for assessing consumer credit risk. In 2004, at the time of launch, FICO research showed a 4.4% increase in the number of accounts above cutoff while simultaneously showing a decrease in the number of bad, charge-off and Bankrupt accounts when compared to FICO traditional.[20] FICO NextGen score is between 150 and 950.

Each of the major credit agencies market this score generated with their data differently:

Experian: FICO Advanced Risk Score

Equifax: Pinnacle

TransUnion: Precision

Prior to the introduction of NextGen, their FICO-based scores were also marketed under different names:

Experian: FICO or FICO II

Equifax: BEACON

TransUnion: EMPIRICA

VantageScore[edit]

In 2006, to try to win business from FICO, the three major credit-reporting agencies introduced VantageScore. According to court documents filed in the FICO v. VantageScore federal lawsuit the VantageScore market share was less than 6% in 2006. The VantageScore score methodology initially produced a score range from 501–990, but adopted the score range of 300-850 in 2013.[21]

CE Score[edit]

CE Score is published by CE Analytics and licensed to sites like Community Empower and Quizzle. This score is sold to lenders and investment banks but is free to consumers. It has a range of 350 to 850.[22][23]

Other credit scores[edit]

Experian has a credit score for educational use only (Plus Score) between 330 and 830 and Equifax has the Equifax Credit Score between 280 and 850. Some lenders use an Application Score between 100 and 990, and Credit Optics Score by ID Analytics Inc. between 1 and 999. Transunion's TransRisk score in the website Credit Karma is between 300 and 850. Several websites (TransUnion, Equifax, Experian, Credit Karma, Credit Sesame etc.) offer different credit scores to consumers, but not used by lenders. Innovis and PRBC are other companies that produce credit scores used by some lenders.

Non-traditional uses of credit scores[edit]

Credit scores are often used in determining prices for auto and homeowner's insurance. Starting in the 1990s, the national credit reporting agencies that generate credit scores have also been generating more specialized insurance scores, which insurance companies then use to rate the insurance risk of potential customers.[25][26] Studies indicate that the majority of insureds pay less in insurance through the use of scores.[27][28] These studies point out that people with higher scores have fewer claims.

In 2009, TransUnion representatives testified before the Connecticut legislature about their practice of marketing credit score reports to employers for use in the hiring process. Legislators in at least twelve states introduced bills, and three states have passed laws to limit the use of credit check during the hiring process.[29]

Criticism[edit]

Credit scores are widely used because they are inexpensive and largely reliable, but do have their failings.

Easily gamed[edit]

Because a significant portion of the FICO score is determined by the ratio of credit used to credit available on credit card accounts, one way to increase the score is to increase the credit limits on one's credit card accounts.[30]

Not a good predictor of risk[edit]

Some have blamed lenders for inappropriately approving loans for subprime applicants, despite signs that people with poor scores were at high risk for not repaying the loan. By not considering whether the person could afford the payments if they were to increase in the future, many of these loans may have put the borrowers at risk for default.[31]

According to a Fitch study, the accuracy of FICO in predicting delinquency has diminished in recent years. In 2001 there was an average 31-point difference in the FICO score between borrowers who had defaulted and those who paid on time. By 2006 the difference was only 10 points.

Some banks have reduced their reliance on FICO scoring. For example, Golden West Financial (which merged with Wachovia Bank in 2006) abandoned FICO scores for a more costly analysis of a potential borrower's assets and employment before giving a loan.[30]